Every for-profit company is a financial asset owned by shareholders. This financial asset has a special attribute – it’s value can be constantly improved. When shareholders assign a CEO for their company, they are expecting the CEO to enhance the value of the asset. Even if this clarity of definition is not used, this is the expectation and makes this the key performance indicator for the CEO.
Thus the CEO needs to understand how the valuation of the company is evaluated and what needs to done to improve it? So, how do we evaluate the monetary value of a company? The common way is to use a multiplier, commonly known as PE ratio and to multiply the company’s profit by this ratio. Normally there is a PE ratio that is common to a whole industry in a given geography (of course that when a more accurate valuation is needed, this common number is adjusted, slightly, for the specifics of the company). Have you ever asked yourself how come it is possible to have a ratio that is common to a whole industry? The only possible reason for that, is that all companies in a given industry and in a given geography must have something common. What is it that is common to all?
If one explores the growth of consumption, of the specific industry, over a long enough period of time (years) and compares a graph of consumption to the performance of the players in that market, over the same period, as depicted by their revenues and profitability the result is quite interesting; the sales graph of all players will be (about) a perfect parallel to the consumption graph (of course lower in the chart), and all companies will have (about) exactly the same level of profitability. Yes, there will be quarters, or even years when some (few) companies will have a different performance (if you zoom in) but overall, over a sufficiently long period of time, most (all) have the same pattern. This fact allows the usage of a common PE ratio to all, as all are pretty much the same. It is important to note than when a company is successful for a meaningful period to demonstrate superior performance (i.e, sales rate of growth greater than the rate consumption grows and profitability greater than the common performance) it enjoys a significantly higher PE ratio.
Closing the loop now, it is the CEO’s job to bring the company to continuously and consistently grow it’s top line faster than the natural rate of growth of consumption while delivering profitability which is clearly better than the common performance of the market peers.
Is it possible? Of course it is, and there are (not too many) examples of such companies that are able to sustain such performance for many years and thus enjoy valuations which are by far greater than the valuations of other players in the same markets. How do they do that? It should be obvious that if a common PE ratio is possible due to the fact that most players in a given market have similar behavior of their key performance indicators, it would indicate that most (all) players are very similar in what they do. Interestingly, many times the reason for doing something in companies is the fact the others in the market are doing it. But, if you want to get different results than the others, it is not likely you will be able to realize them by doing the same things.
The KEY for growing top line faster than the market consumption rate of growth coupled with profitability greater than the common market peers performance is in charting your own unique path. It is in leading change that creates a differentiation. Change that is not because other competitors are implementing it.
To answer the next question – what to change? Maybe it is a good idea to map the changes that are not likely to result with the desired outcome; Product innovation is commonly one of the key areas of search, but in spite of it’s importance, is not likely to result with breakthrough performance (honestly, how many companies do you know that sustain outstanding performance as a result of product innovation?), it will also not come as a result of cost cutting (which is the next common area of search). Yes, cost is important, but your ability to reduce it is highly limited and even disregarding the immense negative effects it carries, even successful cost cutting initiatives drain management attention and distract it from its key area of focus – increasing revenues (profitably).
How can the CEO lead the company to profitably increase revenues? it starts with answering what will enhance the customer’s perception of value? Customer perception of value is the key reason for the customer to choose from whom they will buy and how much they are willing to pay. And the product/ service sold is just one consideration. All market players can offer the same product/ service (and even if not now, they can get to this ability relatively quickly). Differentiation of the offering is not about different product, it is about the way the customer can realize meaningful value from doing business with the company vs. buying from competition. This differentiation has another key attribute, it should not be something that is easy to imitate, as in this case competitors will do the same rapidly (consider the Zara case, where even though Zara is sharing with the world what is it that they are doing differently, no competitor is copying them, why is it? ). A good value proposition is measured in two key measures: Conversion – how many of the offers to customers turn into orders/ sales and Price – how often the actual price payed is greater than the common accepted market price. Of course, MnA can be another way to grow top line fast, but this will keep the challenge of profitability in place, and eventually return to the same place. So, MnA can be an initiative that is merged into the same backbone – enhance customer perception of value to the extent the customer has a clear preference to buy from the company and willingness to pay (at times) premium for that.
Once this new value proposition to the market is verbalized, all parts of the system must be synchronized to ensure the company can stand up to the commitment. When all parts of the system are well synchronized the new offer can be launched and the company can start increasing sales faster than the market natural growth (this also means companies are better off playing in markets where their market share is relatively small) and profitability (thorough price increase and better utilization of its resources, resulting from the improved synchronization of resources). The fact that the new value proposition is difficult to imitate, ensures that this level of performance can be sustained for long period of times. When chosen correctly, long periods are measures in many (more than ten) years.
It is imperative that boards of directors make it clear to their assigned CEO’s that the key performance measure for the CEO is the company’s valuation, it is crucial for the CEO to realize that the only way to achieve this is through bringing the company to grow top line faster than the market natural rate of growth coupled with profitability grater than the common market peers profitability. And lastly it is essential for the CEO to be bold and lead the company on a unique path, make choices to offer customers value that no competitor can (at least not in the short and medium horizon) and have all parts of the system synchronized with that. Be different is the only way to stand out.
